Stabilization of RMB Helps U.S. Regain Rationality

The exchange rate is a hot political issue between China and the United States. Recently Premier Wen has clearly claimed that the RMB is not undervalued and the U.S. has a responsibility to maintain a stable exchange rate in order to assure investor confidence. This is a firm response to President Obama’s earlier allegation that the RMB was undervalued. From a realistic economic and international trade perspective, Premier Wen’s argument is objective and reasonable, but some U.S. politicians and economic scholars such as Paul Krugman have requested that the U.S. government adopt a tough policy toward, and even sanctions against, China.

Recently congressmen from both parties adopted a high profile approach in the exchange rate issue, suggesting economic sanctions and requesting that the government take action toward China. Krugman claims that the undervalued RMB has slowed down the global economic recovery; otherwise, the world economy could grow 1.5 percentage points more. Such theory arouses more conflict. He also says that the U.S. should not be afraid that China will sell off U.S. Treasuries; such a move would only devalue the U.S. dollar and boost American exports. Obviously Krugman’s political prejudice obscures his scientific analytical power. He has completely forgotten that a stable Chinese exchange rate and cheap Chinese exports are a factor in stabilizing the world economy and global financial system. He has further forgotten that if there is a currency war between the U.S. and China, it will not only cause the devaluation of the U.S. dollar, but it will touch off a currency crisis in the U.S. and throughout the world. In such an ultimate crisis, the whole world will lose, but the key is who can best protect itself against the onset of this super tsunami. China is in a far better position than the United States. Rapid devaluation of the U.S. dollar comes before export growth. The whole U.S. and global financial system would be turned upside down. However, a bad deed can turn into something good; the world economic and financial system would be reborn and new rules of the game would appear earlier. The U.S. “dollar empire” would become a historical noun.

At present, the U.S. approach in the exchange rate policy is highly politicized and sentimental. It all depends on the State Department. The Treasury Secretary Timothy Geithner currently remains rational, and one hopes that President Obama also understands the reality of the situation. Of course, there are clear-minded people, including many Americans. The United Nations points out that the stabilization of the Chinese exchange rate is beneficial to itself, as well as to the global economy. A Wall Street Journal editorial from yesterday negated the current market-directed exchange rate opinion. It considered that China had its reason to guard against U.S. pressure, and pointed out that gradual appreciation of the RMB could not resolve the problem. On the contrary, it caused more speculative activities.

Under current circumstances, China can only wait for the U.S. to be rational again, but at the same time it has to remain firm. From a political point of view, the exchange rate involves sovereignty just as, according to Premier Wen, it involves national interest. Thirteen billion people are watching. China is not Japan; she is not a U.S. military colony. Besides, the trend of the RMB exchange rate needs to be analyzed from an objective, economic standpoint. On current account, the import-export trade gap greatly narrowed last year, lowering the Chinese GDP growth rate by 4 percent. It is similar this year. The trade gap dropped by almost 50 percent for the first two months. This will have a negative impact on recovery; pressure on the RMB will result in depreciation, not appreciation.

Moreover, there are two more new, unfavorable developments. The first is the increase in labor costs due to a labor shortage; the second is overall inflation on an upward trend, which is even higher than the U.S. inflation rate. Both these factors can increase pressure on RMB depreciation. In terms of capital flow, expectation of RMB appreciation continues to be a hot issue under the pressure of American politics. Major banks are all trying to guess when the RMB will appreciate. Thus any hint of appreciation results in an influx of hot money*. The argument that RMB appreciation would improve international trade imbalance is impractical. In light of the above, it is appropriate for the RMB to remain stable over the next year in order to slow the drop in the import-export trade gap, and to shatter international speculators’ expectations of RMB appreciation, thus preventing the influx of hot money. Nonetheless, China’s firm stance on the exchange rate policy will ultimately help the U.S. to be rational again. By that time, a new page will be turned in the Sino-American relationship.

*Editor’s Note: “Hot money” is defined as money that is quickly moved from one type of investment to another, in order to take advantage of changing international exchange rates, or for the purpose of high yields on short-term investments.